Tesla sales are booming, but can it deliver on earnings and cashflow?

Reservations for Tesla’s new Model 3 are booming, but the company is still burning cash and is set to report another loss per share. Investors, facing share price volatility, will want to see it deliver on its promise to turn a profit and deliver cash flow this year.

IG Analyst

2016-04-20T09:46:33+0100

Source: Bloomberg

Tesla (TSLA) is set to report another loss per share when it reports first quarter results, after significantly missing earnings expectations for the previous quarter, and it’s going to have to again convince investors it can hit its targets of delivering 90,000 cars, profits and positive cash flow this year.

The electric car maker’s loss widened significantly in the fourth quarter and missed market expectation. But its shares rallied strongly on the day it released the results, after Chief Executive Elon Musk pledged a 60% to 80% increase in vehicle sales this year, promising it would turn a profit on an adjusted basis, and will start generating positive cash flow in March.

It’s expected to report an adjusted loss of $0.58 per share for the first quarter, narrower than the $1.22 a share loss it reported a year earlier, as revenue is set to increase to $2.07 billion, from $939.9 million, driven mainly by higher sales of its Model S. That would be a step in the right direction.

However, Tesla shares trade at valuation multiples far in excess of any other car company. Those multiples have fully priced in a successful expansion into the mass market segment, even though the first new affordable Model 3 sedan is not expected to roll off the production line until the second half of 2017.

Tesla’s current models are oriented to the premium end of the market. The Model S starts at about $75,000 before incentives. The Model 3 is the company’s attempt at getting into the mass market segment, and is expected to retail at about $35,000 before incentives. With a lower price point, Tesla needs to start producing and selling significantly more cars if it is going to start generating cash and sustainable profits.

Tesla began taking orders for the Model 3, its fourth car, on 31 March. Pre-orders have already broken the 400,000 mark, a high level for any new car launch. This is good news for the electric car maker, but it also presents a big issue as Tesla continues to burn through cash at a rapid rate as it tries to build up capacity to meet the huge demand for its cars.

Tesla’s popularity and lofty valuation create severe execution risks as it tries to achieve Musk’s goal of delivering 500,000 cars by 2020. Tesla was burning through cash at a rate of more than US$400 million per quarter all of last year even before deliveries of its Model X began.

Tesla’s delivered 14,820 cars in the first quarter, below its own guidance of 16,000 cars. It cited component shortages for the Model X in January and February as the primary reason for the shortfall. Tesla also reiterated its guidance of delivering 80,000 to 90,000 cars in 2016, which still looks achievable provided the company manages to avoid further component shortages.

Tesla’s share price is likely in for some major volatility under these uncertain conditions. The company has to produce and sell much higher volumes of the Model 3 than its previous cars, and it may struggle to meet the demand necessary to make it profitable.

Investors shouldn’t underestimate the ability of other major car manufacturers to offer stiff competition in the electric vehicle market. Daimler shareholders may have raised concerns about a lack of Mercedes alternative to Tesla cars, but BMW seems to have priced its i3 electric vehicle in direct competition to the Model 3.

The i3 is already available, whereas Tesla Model 3 customers are facing a long wait for their car once they start hitting the roads in 2017. It remains to be seen whether those customers are happy to continue with huge Tesla waiting periods as new options from other competitors begin to proliferate.

The good news for Musk is that based on Tesla’s recent earnings history, the initial stock price reaction seems to be relatively immune to earnings and revenue expectations misses. There’s been a positive stock reaction more often than not, irrespective of the numbers.

Tesla’s stock has performed an impressive reversal since hitting an intraday low of $141 in early-February. It still looks to be in a steady uptrend, but it has recently been repulsed at the $265 level, which corresponds to a similar level of resistance seen in September. A strong close above the $265 level would be a very bullish sign for the stock. If the stock does start to pull back, a drop through the 20-day moving average would likely indicate that there is plenty of momentum behind the stock price decline.

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